… that uses the correct valuation approach. Disclosure: we are two of the co-authors, so we would say that.
The article, “The Valuation of No-Negative Equity Guarantees and Equity Release Mortgages” by Kevin Dowd, David Blake, Dean Buckner and John Fry has just been accepted by the well regarded academic economics journal, Economics Letters.
To quote the abstract:
We outline the valuation process for a No-Negative Equity Guarantee in an Equity Release Mortgage loan and for an Equity Release Mortgage that has such a guarantee. Illustrative valuations are provided based on the Black ’76 put pricing formula and mortality projections based on the M5, M6 and M7 mortality versions of the Cairns-Blake-Dowd (CBD) family of mortality models. Results indicate that the valuations of No-Negative Equity Guarantees are high relative to loan amounts and subject to considerable model risk but that the valuations of Equity Release Mortgage loans are robust to the choice of mortality model. Results have significant ramifications for industry practice and prudential regulation.
The significance of the article is not in the results, which are similar to those in our Eumaeus Guide, but rather in the fact that this article went through a rigorous refereeing process. Even better, the refereeing process was double blind, so neither the referee(s) nor the authors were aware of each others’ identities.
An ERM/NNEG research article undergoing an independent refereeing process is something that we haven’t seen much of in the recent UK actuarial space.
To fend off any purists who might otherwise write to correct us, we emphasise that this article is not the first article to address NNEG valuation in a refereed journal. There have been a number of those over the years, but not too many, and perhaps the most interesting is “On pricing and hedging the no-negative-equity guarantee in equity release mechanisms,” by Johnny Li, Mary Hardy and Ken Seng Tan, which was published in the Journal of Risk and Insurance in 2010.
The Li-Hardy-Tan approach is quite different to ours, however – in fact, their approach is similar to that used by Tunaru or, rather, to put it the right way round, Tunaru’s approach is similar to theirs, whereas our approach is different from theirs. But as far as we can tell, ours is the first refereed journal article to address the valuation of UK Equity Release Mortgages, and it is the ERM valuations that firms ultimately care about.